More Firms Enjoy Tax-Free Status

January 17, 2012

Over the past several decades, a growing number of American businesses have been able to avoid having to pay anything toward federal corporate income taxes. These firms don't employ an army of accountants to shield profits in complex tax shelters. Their enviable tax position is perfectly legal and has been encouraged by Congress and state governments. Known as pass-throughs, these firms have been granted legal immunity from the tax liability in increasing numbers, says the Wall Street Journal.

The percentage of U.S. corporations organized as nontaxable businesses has grown from about 24 percent in 1986 to about 69 percent as of 2008, according to the latest-available Internal Revenue Service data.

By some estimates, more than 60 percent of U.S. businesses with profits of $1 million are structured as pass-throughs, the highest rate among developed countries.

The popularity of tax-exempt status is one big reason why federal corporate tax collections amounted to just 1.3 percent of gross domestic product in 2010, compared with 2.7 percent in 2006 and 6.1 percent in 1952.

Businesses have increasingly lobbied for broader exceptions to the corporate income tax, while others restructure in order to fit their companies into preexisting exceptions. Congress has been more or less compliant in this process, gradually creating more classes of corporations that qualify. All of this pressure is likely brought to bear because businesses are so keen to avoid the 35 percent corporate tax rate, one of the highest in the world.

Many of these fortunate corporations defend their enviable position by pointing out that the federal government still receives significant tax revenue from their operations: the government still taxes the capital gains that are reaped from corporate operations and distributed among ownership. Detractors, however, are quick to point out that for non-tax-exempt competitors, these profits are normally taxed twice. This argument can be seen in the tax burden of KKR, a large private-equity concern:

KKR reported earnings of about $1.3 billion in its pass-through structure for 2010.

KKR paid $74 million in corporate taxes due to taxable subsidiaries when its liability would normally have been $523 million, creating savings of $449 million.

Even after the individual taxes are removed in addition, the pass-through structure still preserves some $277 million in saved taxes.